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DEVELOPING COUNTRIES & FOREIGN CAPITAL.
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Examines economic & political benefits & risks, need for balanced development strategy, examples (Indonesia, Chile, Mexico).... More...
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Paper Abstract:
Examines economic & political benefits & risks, need for balanced development strategy, examples (Indonesia, Chile, Mexico).

Paper Introduction:
A basic policy question facing the leaders and economic ministers of emerging countries is the degree to which they should open their economies to the international financial system. By opening themselves to global capital markets, these countries can borrow development capital that would otherwise have to be squeezed as savings out of their domestic economies--economies in which average income is already low and severe poverty often widespread. On the other hand, by opening their economies to foreign capital, developing countries inevitably cede some control of their economic fate to the lenders of that capital. The risks of doing so are both economic and political. While financial liberalization can bring in more development capital, that capital may surge away again, or become more

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(1985). Even without fullliberalization, developing countries can still gain access to capital, andare tempted to do so while retaining a degree of leverage over theirinternal financial structures. 13). The current debate over the Southeast Asianfinancial crisis underlines the paradox: "When banks believe that theavailability of dollars to meet foreign exchange obligations will beguaranteed by the IMF," writes economist Martin Feldstein, "they will notlook carefully at the foreign exchange risk of the debtor countries" (1998,p. On the other hand, by opening their economies to foreigncapital, developing countries inevitably cede some control of theireconomic fate to the lenders of that capital. (1998, March/April). This complex interaction of the political and the financial poses aproblem for the international financial system as well as for individualdeveloping countries. 3 ). In Calvo, G. Gilibert, P-L., and Steinherr, A. 123). Goldstein, M., and Calvo, G. A. The political dimensions offinance in economic development. Haggard, S., and Lee, C. Maddison, A. 2 1-29. The risks of doing so are both economic and political. Private capital flows toemerging markets after the Mexican crisis. 2 -33. The experience of the Southern Cone countries (Argentina, Chile, and Uruguay) with financial liberalization and internationalization played an important role in demonstrating that reduced government intervention does not in itself guarantee an efficient financial market (Haggard and Lee, 1993, p. MacIntyre, A. The latterwas the case in Mexico in 1994: "Mexico received an unusual dose of badluck in 1994, in the form of both a turn in the international interest ratecycle and unfortunate domestic political developments" (Goldstein andCalvo, 1996, p. Rapid growth may promote a bubblepsychology, producing wastful mis-investments and a sharp downturn when thebubble bursts. (1993). A., Goldstein, M.,and Hochreiter, E., eds., Private Capital Flows to Emerging Markets Afterthe Mexican Crisis. H, andMaxfield, S., eds., The Politics of Finance in Developing Countries.Ithaca, NY: Cornell University, pp. H. 116). 7- 8). That is, the very mechanism designed to maintain finacialstability can promote excessive risk-taking and increase the danger of amajor bubble collapse in the future. A basic policy question facing the leaders and economic ministers ofemerging countries is the degree to which they should open their economiesto the international financial system. In Haggard, S, Lee, C. The former is subject to distortion by "favored sectors" orby leaders' associates, the latter to powerful local interests or to suddenabrogation by governments ignoring their own ideology. ForeignAffairs, 77, pp. In Haggard, S, Lee, C. However, the "Asian strategy" was founded on some important hiddenassumptions: Advocates of intervention in financial markets implicitly assumed a competent, informed, and "strong" government whose motives were to maximize social welfare by offsetting and correcting market imperfections. All too often, however,capital rationing has become politicized--capital being apportioned topowerful and favored sectors, or even those with personal ties to theleadership. Two Crises: Latin America and Asia 1929-38 and1973-83. The practical problem for these developing economies is maintainingstability or sustainability of growth: "Sustainability" of a given capital inflow is ... By opening themselves to globalcapital markets, these countries can borrow development capital that wouldotherwise have to be squeezed as savings out of their domestic economies--economies in which average income is already low and severe poverty oftenwidespread. The ready available of international capital, indeed, widens therange of options available to governments. A. H, and Maxfield,S., eds., The Politics of Finance in Developing Countries. Washington: Institute for International Economics, pp.115-31. 123-64. 235). Yet models of rent seeking and regulatory capture suggested that government intervention was more likely to reflect pressures emanating from powerful groups capable of extracting policy favors: in different countries, these might include rising manufacturing groups, the banking sector, or simply personalistic networks tied to top executive officials (Haggard and Lee, 1993, pp. J. In Haggard, S, Lee, C. Such disruptions of steady growth can be produced by changes in theglobal economy, by internal political developments, or by both. The danger they face is, primarily, "prolonged periods ofoverinvestment in any particular merket will eventually prove unsustainableand give rise to the possibility of speculative bubbles" (Gilibert andSteinherr, 1996, p. Moreover, the authoritarian governments that prevailed in theregion readily ignored their own free-market ideology when circumstancesmade it useful to do so. The triggering domestic political factor was theleftist peasant revolt in the state of Chiapas, but the resulting financialrepercussion turned a regional insurgency in a remote district into apotential national crisis. "Repressed" financial systems violate the theory of marketliberalization, but in a world awash in capital, such policies do not makeforeign capital unavailable in practice. Even the powerful army eschewed the sort of corruption among officersthat has often been found in developing countries under military rule.According to an account in the early 199 s, "signs indicate that seniorarmy leaders have concluded that pervasive corruption has the potential tobe regime-threatening" (MacIntyre, 1993, p. (1996). 81). H, and Maxfield,S., eds., The Politics of Finance in Developing Countries. Regulatory revenge: the politics of free-market financial reforms in Chile. Nevertheless, the question of financial liberalization is todaylargely one of degree. Thus, in the wake of a financial crisis in 1982,the Pinochet regime stepped into the economy, intent on ensuring continuingpolitical stability and averting threats to the regime (Hastings, 1993, pp.222-29). On the other hand, experience in Latin America has indicated that, if"repressed" financial policies based on government intervention are proneto distortion, fuller liberalization and reduced government interventionare also no panacea. In other words, so long as the government managers who rationedcapital did so with impersonal efficiency and wise forejudgment, as in thepopular 198 s image of Japan's powerful industrial and financial ministry,MITI, a "repressed" strategy could work well. A., Goldstein, M., and Hochreiter, E., eds., PrivateCapital Flows to Emerging Markets After the Mexican Crisis. Refocusing the IMF. The experience of the 198 s and 199 s, in developing regions fromEast Asia to Latin America, suggests that it is fruitless to search forsome overall master theory of economic development that either the IMF orthe economic policy managers of individual countries can follow as auniversal rule. In these countries, the game of "favored sectors" was played not bythe government, but by the interest groups directly, acting as internalpower blocs. Hastings, L. Autarkic development, as attempted by Communist andsome other countries in the past generation, has proven a failure.Moreover, unlike the situation prior to the 197 s, when it was harder toborrow internationally, foreign capital is now readily available andeagerly lent (Haggard and Lee, 1993, p. (1993). It has notbeen "favored sectors," or army officers, who siphoned off developmentcapital, but the Suharto family and its cronies. In Latin America, for example,IMF-bashing is a persistant feature of regional politics (Maddison, 1985,p. Indeed, particularly in the198 s, the successful performance of East and Southeast Asian countriesthat followed such policies argued in their favor: the "Asian strategy"appeared to produce both more rapid national development and a betterreturn on capital invested in those economies. (1993). 3-2 . With the financialcrisis of 1997, however, it became clear that, in Indonesia, control fromthe center went hand in hand with corruption at the center. An economic downturn may then lead to a political crisis.So long as times are good, nationalist grumbling about foreign investmentis likely to be muted, but if times turn bad--and particularly if leadersare compelled to impose austerity measures by the International MonetaryFund (IMF), resentments may turn explosive. 117). "In the period since the mid-197 s,systematic political exclusion has become institutionalized, with policydecisions being shaped by bureaucrats operating in a manner largelyunconstrained by organized political action from societal groups"(MacIntyre, 1993, p. References Feldstein, M. Ithaca, NY:Cornell University, pp. important, especially for middle- and upper-income developing countries that have emerged as acceptable investment targets in the eyes of the international financial community because they have achieved a degree of political stability, financial sophistication, and market openness (Gilibert and Steinherr, 1996, p. Such a financial system has beencharacterized as a repressed one. "In a 'repressed' financial system, thegovernment maintains artificially low interest rates. Because this inducesan excess demand for credit, the government is drawn into the process ofrationing financial resources among competing uses" (Haggard and Lee, 1993,p. 233-82. Neither establishing government-directed "repressed" financialsystems nor embracing full liberalization have thus proven to be foolproofstrategies for making the most effective use of foreign capital in nationaldevelopment. Ithaca, NY:Cornell University, pp. Organization for Economic Co-Operation and Development (OECD).----------------------- 1 What role for the officialsector? Washington:Institute for International Economics, pp. 7). (1996). In a capital-rich world, it is both logical and inevitablefor countries to open thir economies to foreign capital, but doing so willalways involve risk and uncertainty, whatever ideological assumptions aremade and whatever specific policies are followed. The politics of finance in Indonesia:command, confusion, and competition. The current situation in Indonesia has underlined the latter case.Economic policy in Indonesia was firmly centralized, with "favored sectors"receiving no formal preference. In Calvo, G. 156). 5). Whilefinancial liberalization can bring in more development capital, thatcapital may surge away again, or become more expensive, due to shifts inthe global financial climate.

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